Tata Steel-ThyssenKrupp: can two problems equal a solution?

Tata Steel and ThyssenKrupp will both take a 50% stake in Thyssenkrupp Tata Steel BV, contributing assets of their respective flat steel businesses, while Thyssenkrupp will also contribute its steel mill services. Photo: AFP

Mumbai: The answer to that question will be known only some years down the line, when this joint venture (JV) walks the talk. An equal JV is difficult to pull off, especially if the management is also shared equally. The motivation on both sides to lighten the load of the steel business, on their books and valuations, has to remain strong, to settle any differences of opinion. This, more than any financial engineering, is what can determine the success of this joint European steel project.

According to a joint statement, Tata Steel Ltd and ThyssenKrupp AG will both take a 50% stake in Thyssenkrupp Tata Steel BV, contributing assets of their respective flat steel businesses, while Thyssenkrupp will also contribute its steel mill services. Tata Steel gets an equal share, despite ThyssenKrupp’s steel business earning more in terms of revenues and Ebitda, and also earning a higher margin.

This could be explained by the liabilities that each will transfer to the business, the market value or potential of the respective steel assets, or ThyssenKrupp’s desire to take these assets off its books. While there is no valuation since there is no consideration, Tata Steel seems to have got a better deal. But this will be clearer when the liabilities being transferred are disclosed.

What do they get in return? ThyssenKrupp has made it clear that the business will move off its books and it will consolidate it under the equity method, showing its share of profit or loss from the joint venture. If Tata Steel follows suit, then it too will account only the profit from this joint venture.

How will Tata Steel’s performance change? Profitability will improve, as its Indian business is more profitable than Europe. In the June quarter, its Ebitda/tonne at Rs 10,623 was double what Europe earned. In addition, the transfer of liabilities will see Tata Steel’s balance-sheet lighten and lower interest payments will further help. Since the combined JV’s profitability is higher than Tata Steel’s current European business profitability, that should mean a better contribution to profits as well.

Once the deal is done, slated to be in place by end-2018, focus will shift to the JV’s performance. The companies have said they expect to see cost savings of €400-600million as a result of integration. That process could take time, however.

The bigger project will start post-2020 when the companies intend to assess their upstream production, liquid steel and hot rolling mills, to see how they can optimise that part of the business, so that the business can focus more on the value-added parts where the margins are higher.

The immediate benefits for both companies are clear — Both are having trouble and don’t believe their European business can do better by itself. The joint venture solves their problem by half, one could say. But both are unlikely to be wedded together indefinitely.

There is one critical difference between the two. Tata Steel is a focused steel company and remains so, even after this transaction. ThyssenKrupp has made it clear that it wants to focus on its industrial capital goods business. Since steel is not strategic to Thyssen-Krupp any more, Tata Steel may end up with a higher stake in the joint venture eventually. A listing too could be a good option, as it could unlock value and make raising capital easier.

The muted reaction in Tata Steel’s share price—it was up by 0.8% by noon—indicates that investors appear to have factored in this joint venture. Since 8 May, Tata Steel’s shares are already up by about 60%, partly also due to higher steel prices. How the two companies work together to make their steel business more profitable and the endgame for the joint venture, will be aspects they will watch out for in the longer run